Coordination of cooperative advertising models in a one-manufacturer two-retailer supply chain system

Abstract

This paper considers cooperative advertising issues of a monopolistic manufacturer with competing duopolistic retailers. Four possible game structures (or power configurations), i.e., Stackelberg–Cournot, Stackelberg–Collusion, Nash–Cournot and Nash–Collusion, are discussed. Under each of four game structures, we develop a decision model for the three partners to design the optimal cooperative advertising policies. Through a comparison among the four models, we reveal how cooperative advertising policies and profits of all participants are affected by various competitive behaviors, and then determine whether the partners have any incentives to transit to a different structure. Also presented in the paper are a centralized decision model and a proposed cost-sharing contract, which is able to achieve perfect coordination of the considered channel, where the utility of risk preference is used to determine the fraction of local advertising costs shared by the manufacturer.

Introduction

Cooperative (co-op) advertising is an arrangement between one manufacturer and one retailer, where the retailer is responsible for local advertising expense with a portion of it paid by the manufacturer. Generally, the co-op advertising funds are mainly used by two parties for newspaper and magazine ads, brochures, radio and television commercials, even special product displays, etc. so that short-term sales can be improved. After World War II, co-op advertising had been extensively used in developed countries like the United States.

Nowadays, with the increasing competition of markets, more and more manufacturers resort to co-op advertising to strengthen the brand name image of their products and motivate immediate sales at the retail level. The automobile industry, for example, is the most common user of co-op advertising (Green, 2000). The US Co-op Advertising Sourcebook published in 2004 identified more than 4000 co-op advertising programs involving 52 different product classes. In addition, it is estimated by the US National Federation of Independent Business that about $50 billion worth of co-op advertising reimbursement per year is offered to the retailers by manufacturers and wholesalers (Kraft & Kamieniecki, 2007). Hence, in order to maximize individual gain, it is both natural and important to know how to determine each party’s optimal cooperative advertising policies in the supply chain. Many researchers discussed this issue from different angles (see Section 2). However, according to our knowledge, few considered the channel with multiple retailers or accounted for the competition between different retailers/buyers in the downstream market. While in many practical supply chains, duopolistic or oligopolistic market is frequently encountered.

In this paper, we consider the co-op advertising issues for a two-echelon supply chain consisting of one monopolistic manufacturer and two duopolistic retailers. We explore two types of game structures (manufacturer-Stackelberg and Vertical-Nash) between two echelons in the channel. As for the duopolistic retailers, we assume that they adopt either Cournot or Collusion. Hence, the co-op advertising problem in our paper will be analyzed respectively in the following four settings: Stackelberg–Cournot, Stackelberg–Collusion, Vertical Nash–Cournot and Vertical Nash–Collusion. Before modeling and analyzing these four settings, we will briefly introduce some real business backgrounds to them.

In a practical supply chain, competition between members of different echelons may be implemented under various game structures: leader–follower structure, Vertical-Nash structure, to name a few. For illustrative purposes, we now introduce a supply chain in China’s home appliances industry, where Zhuhai Gree Corporation (Gree), one of the top-niche air conditioning makers, sells its products through GOME Appliance Co., Ltd. (GOME), a home appliances retail giant in China. In the starting stages of GOME, Gree had complete control over GOME and hold the power to first announce it wholesale price, brand name investment, local advertising allowance, etc. to force the GOME to follow its decision. Therefore, in that time, a typical leader–follower game structure was observed between the two echelons of this air conditioning supply chain. However, the subsequent couple decades saw GOME growing, at an astonishing speed, into the largest home appliances retailer in China. GOME, along with a few other Chinese home appliances retailers like Suning Appliance Co., Ltd. (Suning), gradually seizes the control of the major sales channels, especially in big cities. These lead to GOME rising in its power and levelling up with Gree to demand advertising allowance and other rights. It is not difficult to recognize an evolving Vertical-Nash game structure between the two companies in this air conditioning supply chain.

Likewise, between the two retailers in the downstream of the supply chain, there also exist various forms of competition, Cournot being one relatively common in the real world. GOME and Suning mentioned above are two home appliances retailers following Cournot. In an industry where size matters, Suning is ready to open more stores in the future as it raises the ante in a battle with GOME. Wal-Mart and Tesco, Carrefour and Auchan, etc. are also cases where Cournot game structure applies. Another behavior pursued by the duopolistic retailers in reality is Collusion, which is a non-competitive agreement between rivals. By collaborating with each other, rival firms look to alter the local advertising effort or price of a product to their advantage. Since overt collusion is usually illegal, most collusion behaviors between two retailers are confidential, including secret agreement, tacit agreement or price alliance, etc. Collusion among retailers, again, is not rare in China. The Beijing-based Guotong Electrical Appliance Company, for example, announced that it has reached an agreement with Asia Financial Service Company. Recently, GOME also revealed its plan to start negotiations on cooperating with its foreign counterparts of which Best Buy Inc. is believed to be a possible choice.

Our main objective of this paper is twofold. One is to reveal how cooperative advertising strategies and the profit of each participant are affected by various competitive behaviors between the two echelons as well as those between the two retailers, and then determine whether the partners have any incentives to transit to a different structure; the other is to introduce a coordinated mechanism that improves both the performance of each party and that of the channel as a whole.

The remainder of the paper is organized as the following. Section 2 provides a review of related literature. Section 3 introduces notations and assumptions. Section 4 shows the decentralized decision models of three members in the two-echelon supply chain. Four non-cooperative game structures are considered and compared. Section 5 presents the centralized decision model among channel members. In Section 6, we present a type of cost-sharing contract to achieve the coordination of the supply chain, and discuss how to design the contract based on the utility of risk preference. The paper concludes with Section 7.